The Changes of Agency Costs in the Life Cycle of Enterprises
Yanliang YU 1 Haina WANG* 2
(1.School of Tourism and Cultural Industry, Chengdu University，Chengdu City
2.School. of Mathematics, Jilin university of finance and economics，Changchun City)
Abstract: This research concentrates on the variations of agency costs throughout the enterprise life cycle. In the start-up phase, managers, employees, and shareholders are frequently integrated, with relatively equitable equity distribution. When confronted with survival pressures, teamwork is robust, and agency costs are not of primary concern. The infusion of investment and the anticipation of going public maintain employee enthusiasm, keeping the costs within an acceptable range. After going public, employees’ mentalities shift upon achieving wealth goals, their drive to strive diminishes, enterprise cohesion wanes, and agency costs soar. As the core business matures, enterprises are liable to fall into a “resource trap”, restricting the expansion of new ventures and influencing employee motivation and agency costs. Although society can optimize the industrial structure through enterprise metabolism, the costs are substantial; internal governance mechanisms can merely alleviate the issues; corporate mergers and acquisitions prove ineffective in resolving agency cost problems in practice. ESOP 100% shareholding is an efficacious approach to tackling the agency problem.
Keywords: Enterprise life cycle Agency costs Business moat Corporate mergers and acquisitions
1. Introduction
In the intricate progression of modern enterprise development, the agency problem has consistently been a focal point for both academia and the business community. An enterprise, as an assemblage of contractual relationships, entails shareholders entrusting the management rights to managers, with the expectation that the latter will operate the business to maximize shareholder interests. However, due to factors such as the divergence of objective functions and information asymmetry between the two parties, agency costs inevitably emerge, posing significant challenges to enterprise operational efficiency, value creation, and sustainable development. The enterprise life cycle theory offers a distinctive perspective for delving into the agency cost issue. Enterprises, analogous to living organisms, undergo diverse stages ranging from start-up, growth, maturity to decline. During each stage, the internal and external environments, business objectives, organizational structures, and personnel mentalities undergo remarkable transformations, which inevitably exert a profound impact on the agency relationship and costs. Hence, thoroughly exploring the variation patterns of agency costs across the enterprise life cycle, dissecting the underlying influencing factors and their action mechanisms, holds crucial theoretical and practical significance for optimizing enterprise governance structures, enhancing enterprise competitiveness, and promoting sustainable enterprise development.
In the traditional agency cost theory, supposing the enterprise revenue is R, the management effort is W, the management compensation is S, and the shareholder return is , the following relationships exist:
R=f(e)，W=g(R)，S=R-W (1)
Managers strive to maximize R to indirectly maximize S for the sake of maximizing their own compensation. Against this backdrop, this research systematically analyzes the variation characteristics of agency costs in different life cycle stages of enterprises, such as the start-up stage, after going public, and when the business develops a “moat”. It also deeply explores the impacts of regulatory mechanisms like social metabolism, internal governance mechanisms, and corporate mergers and acquisitions on agency costs and reveals the crucial role played by human factors, aiming to offer theoretical and practical guidance for enterprises to effectively address the agency problem and achieve long-term stable development.
2. Start-up Stage
At the inception of a start-up, the team is integrated, with relatively fair equity and interest distribution and close cooperation. At this time, agency costs are not critical. After the introduction of venture capital, all parties have the expectation of making profits from going public. Although agency problems exist, the team remains active and the costs are controllable. In the current mainstream business operation models, not all scenarios present substantial agency cost issues. In the start-up stage of an enterprise, the company’s managers, employees, and shareholders are usually the same group, namely the entrepreneurial team. Although there are distinctions between the lead founder and co-founders within the founding team, these differences are primarily based on ability and capital investment. Essentially, fair distribution of equity and interests can be achieved. Moreover, start-up enterprises face enormous resource pressures and survival crises. Any unnecessary internal friction could plunge the enterprise into jeopardy. Given the game situation where everyone would perish if the ship sinks, team members mostly work together and strive hard. Internal management problems are relatively less severe at this time. Enterprise failures at this stage are more often due to incorrect business directions or insufficient resources. Although agency costs exist, they are not the main concern. As the enterprise expands initially, the funds initially invested by the founders or the team will no longer meet the development needs of the enterprise. At this point, if the enterprise has promising prospects, angel investors and venture capitalists will enter. Meanwhile, although the founders and the team lose part of the enterprise’s equity, as long as the enterprise develops smoothly and goes public, the wealth value brought by the remaining equity in their hands is still extremely significant. To convert these expected wealth into actual funds and fulfill their career aspirations, the entrepreneurial team usually maintains a vigorous working state before successful listing. Of course, cases where going public is merely for money-making and deceiving investors are excluded. New employees who join during the angel investment and venture capital stages will also obtain a portion of the company’s shares. Although the quantity is far lower than that of venture capital institutions and the founding team, if the enterprise can successfully go public, their returns will still be considerable. Therefore, although management and employees have diverged at this time and agency problems have emerged in enterprise operations, under the allure of the wealth explosion after going public, the working status of the employee group remains active, and the agency costs of the entire organization are within an acceptable range. At this time, introducing Lc to represent the scale of enterprise human capital, we obtain the formula (2):
R=f (e，Lc) （2）
Since the enterprise is far from reaching the stage of diminishing returns to scale, Lc has a positive impact on enterprise profit R at this time.
3. Changes after Going Public
Once a company successfully goes public, a significant portion of the work team may shift from the previous striving state to a conservative state. This is because for both the founding team and early employees, their primary work goal – achieving a substantial increase in wealth – has been accomplished. At this time, the wealth effect brought by continued work is far less than before, and new ideas may arise in their minds: “I have worked hard for so many years and it’s time to enjoy life and pursue higher values of life, such as the idyllic fields of poetry and the distance.” Although some individuals still maintain their career ideals after achieving wealth freedom, it is undeniable that at the moment of going public, the fattest fruits of enterprise growth have been harvested. Therefore, the overall striving drive of both old and new employees can no longer return to the pre-listing state. Just as the saying goes, “Although the general may be willing to fight to the death, the troops are no longer willing to follow.” The wealth expectation brought by going public once deeply bound the interests of all employees and managers. After going public, this interest binding gradually disappears. The enterprise gradually transforms from a place where everyone works together to an ordinary workplace. Working hard and working with dedication are two completely different states, and agency costs rise sharply.
If all positions except management are routine jobs, the theory of (1) holds, and e is the main influencing factor of R. However, the real situation is that a large number of positions outside management are non-routine jobs, and there is ample space for laborers to exert their subjective initiative. They are human capital rather than simple labor. Here, Lc is used to represent the scale of enterprise human capital, and the effort level of human capital is E. Introducing them into the model, we can obtain:
R=f (e，Lc)+h(e,Lc,E) （3）
S=R-(W+WL) （4）
f and h represents the impact functions of management and human capital on corporate earnings. The larger the Lc, the larger the scale of the enterprise, the higher the cost of delegation and agency, and the greater the difficulty of collaboration between human capital, which negatively affects the variables in the f and h functions; On the premise of ensuring their own profit W, the management has the motivation to reduce human capital compensation WL in order to maximize S, which in turn has a negative impact on E. In order to reduce this negative impact, the management will develop a detailed management system to prevent unethical behavior of human capital and format the work content of positions that require subjective initiative. Human capital can only complete established standardized actions, resulting in rigid organizational operations. Therefore, in the h-function, e is a negative impact. E is no longer the only influencing factor of R, and there is no monotonic positive correlation.
4. Business Moat and the Value of Mergers and Acquisitions
As the original core business of an enterprise matures, the industry entry barrier – the “moat” – is formed and provides a stable source of profit for the enterprise for a certain period. Although the growth ceiling has emerged, this business remains the stable cornerstone of enterprise profits. The expansion of new businesses and the research and development of new technologies are also carried out, but their success is far from being a matter of life and death. This is equivalent to the fact that in new fields, enterprises have the resources for progress but lack the determination and internal strength for progress. Short-video entertainment for Tencent, short-video e-commerce for Alibaba, and autonomous driving for Baidu are all such cases. To some extent, the mature original core business can also be regarded as a “resource trap”. Enterprises often find it difficult to break out of their comfort zones due to excessive dependence on existing advantages, thus restricting exploration and development in new fields. Of course, there are occasional exceptions. Tencent successfully launched WeChat in the mobile Internet era, and Microsoft invested in Open AI. These are all successful expansions of the original business or successful investments in others. However, overall, successful cases of expanding completely new businesses far from the core business and achieving a market position comparable to that of traditional businesses are rare. However, society is constantly evolving and the times are advancing. Information dissemination methods have shifted from print media to computers, mobile phones, and possibly VR. Content forms have gradually evolved from text and pictures to videos. Business models have changed from markets and supermarkets to online stores, and then to short videos and live broadcasts. Sooner or later, the core business of listed companies will face the risk of being phased out or marginalized, just as the natural resources of a certain country or region will eventually be depleted or replaced.
When the core business reaches the ceiling and new business expansion is difficult, investment and mergers and acquisitions often become an important strategic choice for company management. Investment and mergers and acquisitions mainly include two categories: one is the expansion of the upstream and downstream of the core business. By investing in or acquiring relatively mature enterprises, the industry moat is deepened, and the business scope is expanded. For example, Alibaba’s investment in logistics companies and the acquisition of Ele.me, as well as Tencent’s extensive layout in the game field. Although such mergers and acquisitions can enhance the comprehensive competitiveness of enterprises, they essentially only reallocate profits among enterprises and do not fundamentally promote social technological progress and efficiency improvement. They mainly achieve monopoly rather than real innovation and development. The other type of merger and acquisition focuses on growth-oriented new companies, aiming to integrate the growth potential of new companies into the growth points of the company and even cultivate them into new core businesses. However, the actual situation is often not optimistic. Many newly acquired companies experience a significant slowdown or even regression in growth after being integrated into the old company. For example, after Alibaba acquired UC Browser and Youku. Although there are some relatively successful cases, such as AutoNavi Maps, such successful cases are rare. There are two main reasons for this phenomenon. First, the business of new companies usually has its unique development laws. After being acquired, it often needs to be coordinated with the business of the acquiring company, and this coordination requirement often conflicts with the original development path of the new company, resulting in its development being hindered. Taking UC Browser as an example, after being acquired by Alibaba, its main function was adjusted to an e-commerce traffic portal. Although it was helpful to Alibaba’s e-commerce in the short term, the development of UC Browser itself was severely restricted in the long term. Second, for the entrepreneurial teams and employees of new companies, being acquired by a large company means that their expected high wealth growth has been realized and cashed in. In this case, their work motivation may be greatly reduced because the returns from further efforts are limited, and the wealth already obtained is sufficient for them to enjoy life and pursue personal ideals. Therefore, the high growth expected by large companies after acquiring new companies is difficult to achieve.
5. The Situation of ESOP 100% Shareholding Model
In decision-making, the ESOP 100% shareholding model transforms employees from laborers into enterprise owners. This change in identity brings about changes in perspectives and interest demands. In the past, due to information asymmetry, managers were prone to be tempted by short-term interests and make decisions detrimental to the long-term development of the enterprise. For example, they might cut research and development investment to boost short-term profits but undermine long-term competitiveness. After employees become owners, relying on their in-depth understanding of the actual situation at the operation front line, they can comprehensively consider from the perspective of long-term development when making decisions. For example, in the decision-making of new product research and development, they can propose feasible plans based on market demands and enterprise capabilities and will not abandon long-term projects due to short-term profit pressures, reducing decision-making errors caused by information asymmetry and short-term behaviors of managers and lowering agency costs. In supervision, the traditional supervision model relies on external audits and internal supervisory boards, which have disadvantages such as untimely information, high costs, and difficulty in detecting problems in real time. Managers are prone to improper behaviors. Under the ESOP 100% shareholding model, the interests of employees are closely tied to those of the enterprise. They have a high sense of responsibility and attention to managers. In daily work, they can observe in real time and question and correct the unreasonable behaviors of managers in a timely manner based on their own interests. For example, they can oppose unnecessary large purchases, reducing the dependence on external supervision resources, lowering supervision costs, and curbing the agency costs brought about by the moral risks of managers. In motivation, the traditional motivation mechanism links management compensation to short-term performance, which easily leads managers to neglect long-term development. For example, they may adopt short-term marketing means that damage the long-term stability of the brand. The ESOP 100% shareholding model provides long-term incentives. The returns of employees are related to the long-term development of the enterprise and the growth of equity value, prompting employees to pay attention to long-term strategic goals and actively contribute to the development of the enterprise. For example, they can pay attention to customer needs and propose innovative solutions to enhance competitiveness. The enterprise can reduce the dependence on traditional motivation means, optimize motivation costs, and lower agency costs. In general, the ESOP 100% shareholding model forms an organic whole through optimizing decision-making, supervision, and motivation mechanisms, reducing the agency costs of enterprise operation, laying a foundation for long-term stable development, and enhancing internal management efficiency and market competitiveness. In the case of ESOP holding 100% of the enterprise’s voting rights, the shareholding union and its standing committee are the highest power structure of the enterprise. Management becomes part of the human capital–Lc .The degree of joint effort is E, and the salary is WL. The following relationships exist:
R=F(E，Lc)，R=WL (5)
WL is positively correlated with E, and Lc still has a negative impact on R. The internal strife and conflicts among management, shareholders, and employees will be significantly reduced.
6. Research Conclusions
First, the cost is low during the startup stage.
At the initial stage of a business startup, the identities of managers, employees, and shareholders highly overlap. The equity distribution is relatively fair based on capabilities and invested capital. Moreover, all of them are jointly faced with severe survival pressures, which enables team members to collaborate closely. The principal-agent cost is not the main contradiction. Even if external investment is introduced later, the anticipation of going public can temporarily maintain the team’s enthusiasm.
Second, the cost rises sharply after going public.
However, the significant event of a company going public changes everything. After employees experience a substantial increase in wealth, their mentalities change, their motivation to strive decreases sharply, the internal cohesion of the enterprise declines, and the principal-agent cost rises sharply. It transforms from a relatively stable state during the startup stage to a significantly deteriorated one after going public. As the enterprise develops, the “moat” effect brought about by the maturity of the main business safeguards profits in the short term, but it also becomes a “shackle” for long-term development. The expansion of new businesses is restricted, and employees’ enthusiasm is hampered by the bottleneck of business development. The principal-agent cost is continuously affected and shows the characteristic of fluctuating with the life cycle stage of the enterprise.
Third, mergers and acquisitions cannot bring new life to the enterprise.
As a strategic means, mergers and acquisitions of enterprises show complex effects in practice. Whether it is the expansion of the upstream and downstream of the main business or the integration of growth-oriented new companies, they have not effectively solved the principal-agent cost problem. Instead, in some cases, they have exacerbated internal contradictions within the enterprise, restricted the enterprise’s innovation and development, and overall, their regulatory effect on the principal-agent cost is limited.
Fourth, 100% ESOP shareholding is an effective way to solve the problem.
The 100% ESOP shareholding model effectively reduces the principal-agent cost from three aspects: decision-making, supervision, and motivation. In terms of decision-making, after employees transform into owners, decision-making errors can be reduced. In terms of supervision, employees can monitor the management in real time, reducing supervision costs and moral hazards. In terms of motivation, employees will pay attention to the long-term strategy, optimizing the incentive cost. Overall, this model forms an organic whole, enhancing the enterprise’s internal management efficiency and market competitiveness.The research was funded by theThe Young Scientists Fund of the National Natural Science Foundation of China (72302097): Research on the Influence Mechanism and Marginal Conditions of Hustle Culture on Minimalist Consumption Based on Self-Regulation Theory
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